On December 8, 2016, the Internal Revenue Service (IRS) released the long-awaited final rules regarding the definition of issue price for tax-exempt bonds and other tax-advantaged bonds contained in IRS Regulation Section 1.148-1(b) under the Internal Revenue Code of 1986, as amended (the Code) (the 2016 Final Regulations).
2016 Final Regulations
General Rule — Actual Sales of a Substantial Amount. As under the prior regulations, the issue price of bonds will generally be the first price at which a substantial amount of the bonds is sold to the public. The issue price of separate maturities of an issue is still determined separately, as are the issue prices of other bonds that do not have the same credit and payment terms.
Definition of Substantial Amount. As under the prior regulations, 10 percent remains a substantial amount.
Definition of Public. The 2016 Final Regulations make it clear that the definition of the "public" includes everyone except parties with a contractual undertaking to participate in the initial sale of the bonds.
- "Public" means any person other than an underwriter or a related party.
- "Underwriter" includes:
(A) Any person that agrees pursuant to a written contract with the issuer (or with the lead underwriter to form an underwriting syndicate) to participate in the initial sale of the bonds to the public; and
(B) Any person that agrees, pursuant to a written contract, directly or indirectly with a person described in (A) to participate in the initial sale of the bonds to the public (for example, a retail distribution agreement).
Therefore, bonds sold to a broker, dealer, or bond house which is not part of the underwriting syndicate (and which does not have a contractual relationship with the issuer or any member of the underwriting syndicate to participate in the initial sale of the bonds) would qualify as sales to the public and count toward the 10 percent threshold.
Special Rule for Private Placements. The 2016 Final Regulations provide that the issue price of bonds issued for money in a private placement to a single buyer, that is not an underwriter or a related party, will be the price paid by such buyer.
Alternative Safe-Harbor Methods Using Initial Offering Price Where Less Than 10 Percent Sold.
Under the 2016 Final Regulations, if less than 10 percent of bonds are sold at the initial offering price, the issuer may nevertheless use the initial offering price as the issue price for the bonds if certain conditions are met. The conditions vary depending on whether the sale was negotiated or competitive. Since the determination is made on a maturity-by-maturity basis, there may be instances where an alternative method must be used for certain maturities of a single bond issue, while the general rule can be used for other maturities. Issuers must select the method used to determine issue price on or before the issue date of the bonds, and identify that method in the books and records maintained for the bonds.
1. Negotiated Sales. In order to use the initial offering price as the issue price in negotiated sales, all of the following requirements must be met:
(A) The underwriters offered the bonds to the public for purchase at a specified initial offering price on or before the sale date, and the lead underwriter provides, on or before the issue date, a certification to that effect together with reasonable supporting documentation, such as a copy of the pricing wire.
(B) Each underwriter agrees in writing that it will neither offer nor sell the bonds to any person at a price that is higher than the initial offering price to the public during the period starting on the sale date and ending on the earlier of:
(i) The close of the 5th business day after the sale date; or
(ii) The date on which the underwriters have sold a substantial amount of the bonds to the public at a price that is no higher than the initial offering price to the public.
2. Competitive Sales. For bonds sold at competitive sale, the issuer may treat the reasonably expected initial offering price on the sale date as the issue price if the issuer obtains a certification of that price from the winning bidder. Competitive sale is defined as a sale of bonds by an issuer to an underwriter that is the winning bidder in a bidding process in which the issuer offers the bonds for sale to underwriters at specified written terms, if that process meets the following requirements: (a) the issuer disseminates the notice of sale to potential underwriters in a manner that is reasonably designed to reach potential underwriters; (b) all bidders have an equal opportunity to bid; (c) the issuer receives at least three bids from underwriters who have established industry reputations for underwriting new issuances of municipal bonds; and (d) the issuer awards the bonds to the bidder who submits a firm offer to purchase the bonds at the highest price (or lowest interest cost).
Supporting Documentation. As described in more detail above, under both the general rule and the alternative methods, the issuer will be required to maintain documentation to support the issue price determinations.
Effective Date. The 2016 Final Regulations will apply to bonds that are sold on or after June 7, 2017.
For more information, the full text of the 2016 Final Regulations can be found here.